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Fool on the Street: Comcast

Comcast is looking good, according to its CEO -- but is it engaging in too much capital spending?

Comcast(NASDAQ:CMCSA) had a good time during 2006, according to fellow Fool David Lee Smith. I'd say his analysis was spot-on. The stock had a nice run over the past year; the company has leveraged its strong triple-play offering of cable programming, broadband Internet access, and VOIP telephony to great fiscal success; and it now serves more than 24 million subscribers. It's a leader among the other giants -- Time Warner(NYSE:TWX), Charter Communications(NASDAQ:CHTR), and Mediacom(NASDAQ:MCCC) -- and it competes effectively with the likes of EchoStar(NASDAQ:DISH) and DirecTV(NYSE:DTV).

So, Comcast has had a lot of past success. The question is: Where do we go from here? Comcast Chairman and CEO Brian Roberts recently spoke at the Bear Stearns 20th Annual Media Conference to give some insight on the future. Here are some highlights.

What about the cash?Here's something I always consider when scrutinizing a potential investment idea: Is the company in question capital-intensive? In a very broad sense, owning a content supplier as opposed to a platform builder would imply an easier route to free cash flow (although not always). Roberts was asked about the current build-out phase for Comcast by interviewer/analyst Spencer Wang, who pointed out that the company seems to have changed its stance in terms of capital spending and that it might not generate as much free cash flow in the short term as originally expected.

Mr. Roberts basically boiled it down to this: Investing in the company's bundled-service strategy is going to pay off years from now in terms of money generation. He posed a simple question: Do we want high free cash flow now, or do we want even higher free cash flow down the road?

I can see his point -- investing for future growth is usually the better choice. What investors will need to keep an eye on is the growth in EBITDA (earnings before interest, taxes, depreciation, and amortization) and operational cash flow -- those metrics must continue to grow, even if capital expenditures take away a lot of their value and leave less free cash flow behind. Mr. Roberts indicated that consumer adoption of Comcast's services is beating expectations, so increased capital expenditures seem warranted.

DSL -- the new dial-up?I'm sure everyone reading this is aware of Comcast's aggressive marketing of its high-speed Internet service; it's obviously a very vital part of the triple-play bundle. Roberts said something I thought was very interesting: DSL could now be considered the new dial-up. He mentioned that Google's (NASDAQ:GOOG) YouTube works more optimally in Comcast's service as opposed to DSL. Indeed, those of you who have seen Comcast's commercials featuring the Slowsky turtles, who love DSL because cable Internet is just way too fast for shelled reptiles, will understand Roberts' contention.

I never thought of DSL precisely in those terms (perhaps because I am still using the real dial-up), but it rings true. Yet the CEO was offered an interesting point: What happens if high-speed cable becomes the new dial-up years from now? That's a fair point. Technologies change rapidly, and sometimes without warning; that's an axiom that will never go away.

Right now, Roberts doesn't seem worried by all the fuss over competing services such as FiOS; he's happy right now with the growth rate in his broadband service. I believe, however, that the future is, as Yoda once pointed out, hard to pin down because it is always in motion. One has to wonder how deep any moat of competitive advantage is when it comes to Internet services -- AOL certainly found out how tough it was.

The demand of on-demandFor the record, I still have regular cable (that plus the dial-up might make you think I'm some sort of caveman). But those of you who subscribe to digital cable will attest to the fact that on-demand services are a big driver of the cable experience. Roberts thinks so, too.

The value of on-demand technologies is obvious -- consumers can watch content whenever they choose. And the variety of content available is increasing over time. Not only is this a great thing for platforms like cable, but it's also a practical way for content concerns like Disney and News Corp. to amortize their vast libraries. A conference member seemed to express a bit of reticence as to the significance of the revenue-growth potential of video-on-demand, but to me, this is going to be the big story going forward for Comcast. Digital distribution continues to transform the ways in which people access content, and as the technology progresses, I believe consumers will look to it as an optimal way to receive various programming.

Besides the issue of top-line expansion, on-demand services also help out in another area, according to Roberts -- they tend to reduce churn rates. It's been said that once people get a taste of cable or satellite, they'll learn never to live without it; I think we all can agree with that statement. To expand on that concept, I think consumers are learning that watching libraries of content at their beck and call is something they really can't part with. Roberts mentioned that average views of on-demand programming are on the rise.

Does Comcast need to trap another mouse?All this talk about content is making me nostalgic. Remember when, a couple years back, Comcast actually wanted to buy Disney? As we all know, that transaction never happened, which probably was just as well, since integrating the two cultures might have been a nightmare. That aside, is Comcast in need of another acquisition target? Since content is, as I just discussed, so important to the company, it would seem to be in management's best interest to own a major content business, correct? This issue was posed to the CEO.

Roberts didn't see it that way. Neither do I. He agreed with a participant's categorization of the potential Disney deal as simply a unique opportunity at the time. The way I see it, he probably believes that Comcast and Disney would have been a strong combination that would have worked, but as a Disney shareholder, I'm glad I didn't have to go through integration issues.

Comcast should stick with what works for it, and it shouldn't feel the need to amass significant debt to get content, especially since it already has interests in various channels. Also, it's always in a position to strike smaller deals and joint ventures in the future, and such projects could be even more effective than some huge takeover (as an example, Comcast was part of a consortium that purchased the MGM library). Granted, having control over Disney would have neutralized the powerful media conglomerate's use of ESPN as a bargaining tool in carriage negotiations. But again, I think synergy is proving to be tougher to execute these days, so staying away from such complicated mergers is a good strategy for Comcast.

A Comcastic conclusionComcast is clearly benefiting from a strong push of its bundled services. Management is resisting skepticism brought against it in terms of capital spending, preferring to engage expenditures now for future cash flows later on. So long as the suite of products remains technologically competitive, shareholders should see increased value over time. The company doesn't need to do an acquisition -- the way it currently deals with content suppliers should suffice. Its main focus should be the marketing of its brand and the support of its subscribers through a robust and reliable customer service architecture.

I'm not normally a fan of platform plays -- I'm more in favor of being on the side of content providers. But I have to concede that Comcast is doing well in its space. A look at its latest earnings numbers shows that it has leveraged past investment years to full advantage by producing excellent cash flow growth -- in 2006, operational cash flow advanced 37% while free cash flow increased 83%, even as capital investment levels rose. Comcast does indeed look like an interesting investment idea.

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Fool contributor Steven Mallas owns shares of Disney. As of this writing, he was ranked 16,184 out of 23,971 investors in the Motley Fool CAPS system. Don't know what CAPS is? Check it out. The Fool has a disclosure policy.